China's Tighter MMF Regulations Won't Halt Sector Growth

China's latest tightening of regulations on money market funds (MMF) is unlikely to slow sector growth significantly, but should lower liquidity risks marginally, says Fitch Ratings. One effect of the changes will be to discourage retail clients from viewing and using their MMF investments like bank deposits, but there will be only a limited impact on most investors, and, moreover, there is a lack of competing investment products for clients.

Assets under management (AUM) in Chinese MMFs reached CNY7.3 trillion at end-March 2018, up 70% on end-2016, which built on dramatic growth in previous years (see chart). Expansion has been driven by investors' search for yield and the proliferation of the e-commerce-related funds, which are linked to major online payment platforms.

The new cap of CNY10,000 on same-day (T+0) redemptions from a single account should lower MMFs' liquidity risk in periods of market stress, particularly for those with high investor-concentration risk. That said, most MMFs have a granular investor base. Average holdings per investor across the industry were around CNY10,000 at end-2017. Yu'E Bao, the world's largest MMF, which had already imposed its own T+0 redemption limit, has almost 470 million investors holding an average of just CNY3,300. Nonetheless, the cap will significantly affect the handful of Chinese T+0 institutional funds. Investors have also been banned from paying bills or making purchases directly from money fund accounts - a step that will have a substantial impact on e-commerce-related funds.

Overall, the regulations move MMF accounts closer to acting as saving products than cash accounts, which might make them less useful to some clients. However, most investors do not hold enough to be affected by the T+0 cap, and those with larger balances can still make unlimited next-day (T+1) redemptions. There are also no direct alternatives for clients: bank deposits offer much lower yields, while wealth-management products (which compete on yield) have longer maturities.

At face value, The T+0 redemption cap will significantly undermine prospects for the development of an institutional MMF sector comparable with the US or Europe in China.. In the US and Europe, specialised MMFs focus on serving large institutional investors, such as corporate treasurers, affording them the ability to make large ticket daily transactions. It is possible, however, that this redemption cap is a step towards eventually establishing separate retail and institutional MMF sectors, with different rules applying to funds depending on their investor type, which would move China closer to the US model.

The new regulations also place a ban on non-bank financial institutions from providing MMFs with funding to help meet same-day redemptions. This will raise the challenges significantly for MMFs' liquidity management, but should also push them to ensure they can meet redemptions from their natural liquidity and sales proceeds, rather than through borrowing.